10-Q/A: Rithm Capital Restates Q1 2024 Financials Due to Accounting Error, Identifies Material Weakness

Rithm Capital Corp. has filed an amended quarterly report restating its Q1 2024 financials due to an accounting error related to the consolidation of certain mortgage securitization trusts and has identified a material weakness in internal controls.

Summary

• Rithm Capital Corp. has amended its Q1 2024 report to restate its financial statements due to an error in accounting for certain private label mortgage securitization trusts.
• The company identified a material weakness in its internal control over financial reporting as of December 31, 2023, which remained as of March 31, 2024.
• The restatement includes the consolidation of certain private label mortgage securitization trusts and other immaterial adjustments.
• The previously issued financial statements for the quarter ended March 31, 2024, should no longer be relied upon.
• The company's Chief Executive Officer and Chief Financial Officer concluded that the company's disclosure controls and procedures were not effective as of March 31, 2024, due to the material weakness.
• The adjustments did not result from any override of controls or misconduct.
• Rithm Capital expects the material weakness to be remediated by the end of the year.
• The company's common stock outstanding as of April 26, 2024, was 483,477,713 shares.

Sentiment

Score: 3

Explanation: The document reveals a significant accounting error and a material weakness in internal controls, which are major concerns for investors. While the company expects to remediate the weakness, the restatement and control issues create uncertainty and negatively impact investor confidence. The sentiment is therefore negative.

Positives

• The adjustments that are recorded in the restated unaudited financial statements did not result from any override of controls or misconduct.
• Rithm Capital expects that the material weakness will be remediated by the end of the year.

Negatives

• The company's previously issued financial statements for the quarter ended March 31, 2024, should no longer be relied upon.
• The company's disclosure controls and procedures were not effective as of March 31, 2024, due to a material weakness in internal control over financial reporting.

Risks

• The company faces risks related to the restatement of its consolidated financial statements, including potential regulatory, stockholder or other actions, loss of investor and counterparty confidence and negative impact on its stock price.
• The company's ability to maintain effective internal control over financial reporting is a risk, including the ability to remediate any existing material weakness and the timing of any such remediation.
• The company's ability to successfully operate its business strategies and generate sufficient revenue is subject to numerous risks.
• Reductions in the value of, cash flows received from or liquidity surrounding, our investments, including the valuation methodologies used for certain assets in our funds, which are based on various assumptions that could differ materially from actual results.
• Changes in general economic conditions, including a general economic slowdown or severe recession in our industry or in the commercial finance, asset management and real estate sectors, including the impact on the value of our assets or the performance of our investments.
• Our reliance on and counterparty concentration and default risks in, the servicers and subservicers we engage (Servicing Partners) and other third parties.
• The risks related to our origination and servicing operations, including, but not limited to, compliance with applicable laws, regulations and other requirements; significant increases in loan delinquencies; compliance with the terms of related servicing agreements; financing related to servicer advances, mortgage servicing rights (MSRs) and the origination business; expenses related to servicing high risk loans; unrecoverable or delayed recovery of servicing advances; foreclosure rates; servicer ratings; and termination of government mortgage refinancing programs.
• Competition within the finance, real estate and asset management industries.
• Interest rate fluctuations and shifts in the yield curve.
• Changes in interest rates and/or credit spreads, as well as the risks related to the success of any hedging strategy we may undertake in relation to such changes.
• The impact that risks associated with residential mortgage loans, including subprime mortgage loans, and consumer loans, as well as deficiencies in servicing and foreclosure practices, may have on the value of our MSRs, excess mortgage servicing rights (Excess MSRs), servicer advance investments, residential mortgage-backed securities (RMBS), residential mortgage loans and consumer loan portfolio.
• The risks that default and recovery rates on our MSRs, Excess MSRs, servicer advance investments, servicer advances receivables, RMBS, residential mortgage loans and consumer loans deteriorate compared to our underwriting estimates.
• Changes in prepayment rates on the loans underlying certain of our assets, including, but not limited to, our MSRs or Excess MSRs, as well as the risk that projected recapture rates on the loan pools underlying our MSRs or Excess MSRs are not achieved.
• Servicer advances may not be recoverable or may take longer to recover than we expect, which could cause us to fail to achieve our targeted return on our servicer advance investments or MSRs.
• Cybersecurity incidents and technology disruptions or failures.
• Our dependence on counterparties and vendors to provide certain services and the risks related to the exposure to counterparties that are unwilling or unable to honor contractual obligations, including their obligation to indemnify us, keep our information confidential or repurchase defective mortgage loans.
• The mortgage lending and originationand servicing-related regulations promulgated by the Consumer Financial Protection Bureau, as well as other federal, state and local governmental and regulatory authorities and enforcement of such regulations.
• Risks related to our Asset Management business, which includes Sculptor Capital Management, Inc. (Sculptor) and Sculptors funds, including, but not limited to, redemption risk, market risk, historical return-related risk, risk related to investment professionals, leverage risk, diligence risk, liquidity risk, valuation risk, risk related to minority investments, foreign investment risk, regulatory risk, risk related to hedging and risk management and investment strategy risk.
• Our ability to successfully integrate the businesses and realize the anticipated benefits of the acquisition of Sculptor.
• Risks associated with our Genesis Capital LLC (Genesis) business, including, but not limited to, borrower risk, risks related to short-term loans and balloon payments, risks related to construction loans and concentration risk.
• Risks associated with our single-family rental (SFR) business, including, but not limited to, the impact of seasonal fluctuations, significant competition in the leasing market for quality residents and fixed costs related to the SFR industry, such as increasing property taxes, homeowners association (HOA) fees and insurance costs.
• Our ability to maintain our exclusion from registration under the Investment Company Act of 1940 and limits on our operations from maintaining such exclusion.
• Our ability to maintain our qualification as a real estate investment trust (REIT) for the United States of America (US) federal income tax purposes and limits on our operations from maintaining REIT status.
• Risks related to the legislative/regulatory environment, including, but not limited to, the impact of regulation of corporate governance and public disclosure, changes in regulatory and accounting rules, US government programs intended to grow the economy, future changes to tax laws, regulatory supervision by the Financial Stability Oversight Council, the federal conservatorship of the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac, and together with Fannie Mae, GSEs) and legislation that permits modification of the terms of residential mortgage loans.
• The risk that actions by the GSEs, Government National Mortgage Association (Ginnie Mae) or other regulatory initiatives or actions may adversely affect returns from investments in MSRs and Excess MSRs and may lower gain on sale margins.
• Risks associated with our indebtedness, including, but not limited to, our senior unsecured notes and related restrictive covenants and non-recourse long-term financing structures.
• Our ability to obtain and maintain financing arrangements on terms favorable to us or at all, whether prompted by adverse changes in financing markets or otherwise.
• Increased focus related to environmental, social and governance issues, including, but not limited to, climate change and related regulations, and any impact such focus could have on our reputation.
• Impact from any of our current or future acquisitions, including, but not limited to, our acquisition of Computershare Mortgage Services Inc. and certain affiliated companies, including Specialized Loan Servicing LLC (SLS), and our ability to successfully complete such acquisitions and integrate the acquired assets, entities, employees and assumed liabilities.
• The impact of current or future legal proceedings and regulatory investigations and inquiries involving us, our Servicing Partners or other business partners.
• Adverse market, regulatory or interest rate environments or our issuance of debt or equity, any of which may negatively affect the market price of our common stock.
• Our ability to consummate future opportunities for acquisitions and dispositions of assets and financing transactions.
• Our ability to pay distributions on our common stock.
• Dilution experienced by our existing stockholders as a result of the conversion of the preferred stock into shares of common stock or the vesting of performance stock units and restricted stock units.

Future Outlook

The company expects that the material weakness in internal control over financial reporting will be remediated by the end of the year. The company also cautions that forward-looking statements involve risks and uncertainties and that actual results may differ materially from those set forth in the forward-looking statements.

Management Comments

• The Companys Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective as of March 31, 2024 due to such material weakness.
• We expect that the material weakness will be remediated by the end of the year.

Industry Context

This announcement comes amid a period of economic uncertainty and volatility in the financial and real estate markets, with rising interest rates and inflationary pressures impacting the performance of mortgage-related assets. The restatement and identification of a material weakness highlight the challenges faced by financial institutions in maintaining robust internal controls and accurate financial reporting in a complex and rapidly changing environment.

Comparison to Industry Standards

• The restatement of financial statements due to accounting errors is not uncommon in the financial industry, but the identification of a material weakness in internal controls is a significant concern that requires prompt remediation.
• Other companies in the mortgage REIT sector, such as Annaly Capital Management and AGNC Investment Corp., also face similar challenges related to interest rate risk, prepayment risk, and credit risk, but the specific nature of the accounting error and internal control weakness at Rithm Capital is unique to the company.
• The company's performance in the origination and servicing segments is comparable to other large mortgage servicers, but the impact of the restatement and material weakness on investor confidence and the company's stock price will be closely watched by the market.
• The company's asset management business, which includes Sculptor, is a relatively new addition to the company's portfolio, and its performance will be compared to other alternative asset managers in the industry.

Legal Proceedings

• The company is or may become, from time to time, involved in various disputes, litigation and regulatory inquiry and investigation matters that arise in the ordinary course of business.
• In 2023, in connection with the acquisition of Sculptor, litigation was filed against Sculptor alleging, among other things, that Sculptors board of directors (the Sculptor Board) and the special committee of the Sculptor Board violated their fiduciary duties, and sought, among other things, to enjoin the transaction with Rithm Capital. An agreement was reached in principle by the parties to settle all claims of the litigation.

Related Party Transactions

• An entity in which Rithm Capital has an ownership interest entered into a loan agreement with Genesis.
• Rithm Capital entered into a management agreement with Adoor Property Management LLC, an entity in which the Company has an ownership interest.
• The company earns substantially all of its management fees and incentive income from the funds, which are considered related parties as Sculptor manages the operations of and makes investment decisions for these funds.
• The company pays certain expenses on behalf of the funds. Amounts due from related parties relate primarily to reimbursements to Sculptor for these expenses.
• The company has a co-investment in a portfolio of consumer loans held through certain limited liability entities.
• The company holds a derivative liability to an affiliate, which is measured at fair value.

Stakeholder Impact

• Shareholders: The restatement and identification of a material weakness may negatively impact investor confidence and the company's stock price.
• Employees: The company's employees may be affected by the changes in internal controls and the remediation efforts.
• Customers: The company's customers may be affected by the changes in the company's operations and financial stability.
• Suppliers: The company's suppliers may be affected by the changes in the company's financial condition and ability to pay.
• Creditors: The company's creditors may be affected by the changes in the company's financial condition and ability to repay its debts.

Next Steps

• The company will implement changes to its internal controls for reviewing key accounting considerations on private label securitization transactions.
• The company will monitor the effectiveness of its remediation plan and will make changes management determines to be appropriate.
• The company will evaluate the operation of these internal controls to determine whether they are operating effectively in order to remediate the material weakness.

Key Dates

Keywords

mortgage servicing rights, MSR, real estate, mortgage loans, asset management, securitization, REIT, internal control, financial restatement, disclosure controls, servicer advances, residential mortgage loans, consumer loans, single-family rentals, Sculptor, Genesis Capital